How to Value L1s?

This episode critically examines how to value Layer 1 blockchains, contrasting app revenue-based "GDP" metrics with traditional fee-based approaches, and explores the shifting value dynamics between L1s like Solana and Ethereum and their burgeoning application ecosystems.

Rethinking Layer 1 Valuation: The "GDP" App Revenue Metric

• Jeff introduces his preferred metric for valuing smart contract blockchains: "GDP," defined as the combined app revenue generated on these chains. He posits that this metric indicates Solana's future earnings potential is currently undervalued.
  • Smart contract blockchains: These are foundational networks (Layer 1s) like Ethereum or Solana that support self-executing contracts, enabling decentralized applications.
  • App revenue (as "GDP"): The total revenue generated by all applications operating on a specific blockchain, used by Jeff as an analogy to a country's Gross Domestic Product.
• This approach diverges from other common metrics, such as Blockworks' "rev" (which measures fees and tips paid for block space access, accruing to validators and stakers). The discussion highlights ongoing debates, especially within the Solana and Ethereum communities, about the most effective methods for valuing Layer 1 tokens.
  • Layer 1 (L1) tokens: The native cryptocurrencies of foundational blockchains (e.g., SOL for Solana, ETH for Ethereum), used for fees, staking, and governance.
  • Block space: The finite data capacity within each block of a blockchain where transactions are recorded.
  • Validators and Stakers: Participants who help secure the network and process transactions, often by "staking" or locking up L1 tokens, and are rewarded with fees and new tokens.
• Jeff, whose perspective seems grounded in finding practical, comparable valuation tools, notes: "I kind of come from one of two angles. So one the the simple angle is if you do it across a few chains um you get numbers that look somewhat similar."
• Actionable Insight: Investors should consider app revenue ("GDP") as a potentially more stable and comparable long-term valuation metric for L1s than volatile fee-based measures, especially when assessing relative valuations across different ecosystems.

Why "GDP" Offers a More Consistent Valuation Lens

• Jeff elaborates that his market cap to annualized "GDP" ratio yields relatively consistent figures (e.g., in the 50s and 100s range) across various blockchains. This consistency allows for more direct, "apples-to-apples" comparisons, similar to how equity analysts use Price-to-Earnings (PE) ratios in traditional markets.
  • Market cap: The total market value of a cryptocurrency's circulating supply.
  • PE (Price-to-Earnings) ratio: A traditional finance metric comparing a company's stock price to its earnings per share, used here as an analogy for valuing L1s.
• He observes that this metric can reveal important nuances. For instance, BNB Chain might appear to trade at a premium ("rich") due to the Binance exchange's strong, somewhat "captive" user base, providing it with a competitive moat. Conversely, Solana may seem undervalued ("cheap"), particularly given its current heavy reliance on memecoin trading, as opposed to Ethereum’s more diversified application portfolio.
• This analytical approach mirrors traditional equity analysis, where companies with diversified revenue streams and strong moats often command higher and more stable valuation multiples than those dependent on a single, potentially riskier, use case.
• Actionable Insight: Researchers should analyze the diversity and sustainability of app revenue sources on an L1. A high "GDP" driven by a narrow or speculative use case (like memecoin trading, as Jeff suggests for Solana) might warrant a lower valuation multiple due to higher risk.

Blockchains as Digital Economies: Analogies to Countries and Cities

• Jeff further supports his "GDP" metric by drawing an analogy between blockchains and self-contained economies like countries or cities. In this framework, the economic activity within the blockchain "country"—represented by the fees paid on its applications (Jeff's "GDP" measure)—becomes a crucial indicator of its vitality.
• This application-driven economic activity directly influences the overall health of the chain, including its net token issuance, which Jeff likens to a government's fiscal deficit.
  • Net token issuance: The rate at which new tokens are created minus tokens that are burned or otherwise removed from circulation. Positive net issuance indicates an inflationary supply.
• The fees generated by applications function like taxes within this "country" model, contributing to the "government's" (the blockchain's) financial stability. Jeff finds this analogy powerful because, as he states, "it sort of works both in logic space comparing chains against real world countries or cities... you can then compare... for taxes and think about the overall thing as like a government."
• Actionable Insight: When evaluating an L1, consider its "fiscal health" by comparing app-generated "taxes" (application fee revenue) against its "deficit" (net token issuance). A robust application economy can underpin a more sustainable tokenomic model for the L1.

Factoring in Token Issuance: When Does It Matter?

• The interviewer inquires whether Jeff incorporates token issuance into his valuation model. Jeff clarifies that issuance becomes a significant factor mainly at extreme levels.
• He points to Ethereum's transition from negative net issuance before the Dencun upgrade to positive issuance afterward, suggesting that while this shift is noteworthy, the level of on-chain activity likely holds greater importance for valuation.
  • Dencun Upgrade: A major Ethereum network upgrade implemented in March 2024, which introduced "proto-danksharding" aimed at significantly reducing transaction fees for Layer 2 scaling solutions.
• For most leading blockchains, such as Solana, net issuance typically hovers around 4-5%. Jeff believes that if issuance remains in the low single-digit percentages (0-5%), its impact on valuation is not substantial. He draws a parallel to Amazon, which has averaged around 1.5% new stock issuance annually over the past decade, a level he deems acceptable.
• Jeff, offering a pragmatic view on token supply dynamics, states: "I think if you're in the sort of 0 to four or 5% it doesn't really matter massively."
• Actionable Insight: Investors should monitor L1 token issuance rates. While low, single-digit inflation may be manageable if accompanied by strong activity and revenue growth, high or rapidly accelerating issuance can dilute token value and should be a point of caution.

Debating App Revenue vs. Direct L1 Value Capture

• The interviewer challenges the direct correlation between an L1's market cap and its "GDP" (app revenue). They argue that applications could achieve high take rates (retaining a large portion of revenue) while settling minimal data or value on the underlying L1, thus limiting direct value capture for the L1 token itself. This suggests that direct L1 fees, despite their volatility, might offer a more direct measure of value accrual to the L1.
  • Take rate: The percentage of transaction value or revenue that an application platform retains for itself.
• Jeff acknowledges this as a pertinent "overtime question," especially given the relative novelty of both blockchains and substantial application-generated fee revenues. He concedes that if application take rates evolve significantly, or as Layer 2 solutions mature and alter fee dynamics, the current premium valuations of Layer 1s could come under pressure.
• The interviewer's critical perspective, highlighting the potential disconnect, pushes Jeff to consider future scenarios where app success doesn't automatically translate into proportional L1 token value.
• Actionable Insight: Crypto AI researchers should meticulously investigate the actual value capture mechanisms between prominent decentralized applications (dApps) and their host L1s. A high "GDP" from app revenue might not sustain an L1's valuation if the mechanisms for value to accrue back to the L1 token are weak or inefficient.

The Future of Value Accrual: Layer 1s vs. Applications

• Jeff observes that, historically, Layer 1s have captured the lion's share of value in market cap terms. He likens this to a hypothetical scenario where Apple (iOS) captures all economic value, leaving none for the applications built on its platform. However, he emphasizes that the decentralized ethos of blockchain technology suggests value should, in principle, accrue more equitably to applications over time.
• He notes that Layer 2 solutions are currently highly profitable ("minting it from a cash perspective"), often paying relatively little to their parent L1 (like Ethereum) while retaining substantial revenue. This indicates a different emerging valuation paradigm.
  • Layer 2 (L2) solutions: Protocols built atop L1s (e.g., Arbitrum on Ethereum) to enhance scalability and reduce costs.
• Jeff speculates that a "real use case," potentially exemplified by a major dApp like Uniswap, could eventually alter its take rate significantly or even launch its own dedicated Layer 1. Such a move would shift the economic balance, making applications, not just L1s, primary centers of value. "Like layer ones actually probably come off a lot and application prices go up a lot," he predicts.
  • Uniswap: A leading decentralized exchange (DEX) protocol, predominantly operating on Ethereum.
• Actionable Insight: Investors should closely monitor the evolving economics of Layer 2s and the strategic moves of major dApps. A fundamental shift towards app-centric value capture could de-premium L1 tokens unless L1s develop robust mechanisms to retain relevance and value.

Solana's Strategy and the L1 Dilemma

• The interviewer points to Solana's strategic initiatives, such as exploring application-specific sequencing, as attempts to navigate a future where successful applications might seek greater autonomy and value retention by migrating to their own Layer 1 or Layer 2 solutions.
  • Application-specific sequencing: A model where individual applications might gain more control over their transaction ordering and processing, potentially enabling them to capture more of the value they generate.
• For Solana to maintain its prominence, it must compellingly demonstrate the advantages of its "global shared state vision." This involves fostering a diverse ecosystem with multiple successful sectors where direct composability on Solana's single ledger offers clear benefits over applications operating in isolation.
  • Global shared state: The concept of a single, unified, and consistent ledger (like Solana's) that all applications can interact with seamlessly.
  • Composability: The ability of different dApps and protocols on a blockchain to interact, integrate, and build upon one another fluidly.
• Jeff concurs with this assessment, describing the dynamic as somewhat "circular": L1s enable application development, but as applications grow large enough, they become the primary drivers of ecosystem value, which can lead them to seek greater independence.
• Actionable Insight: For L1s like Solana, cultivating strong network effects through superior composability and a vibrant, interconnected application ecosystem is paramount to retaining value as dominant applications mature and explore avenues for greater economic self-determination.

Blockchains as "Corporates": Adapting the Narrative for TradFi

• Jeff highlights an emerging trend where blockchain organizations are becoming more proactive in managing their value accrual narratives. He references recent discussions with teams behind various blockchains who are diligently working to articulate their value propositions and development roadmaps to investors, especially those from the traditional finance (TradFi) sector.
  • TradFi (Traditional Finance): The established financial system, encompassing banks, investment firms, stock markets, and related institutions.
• This concerted effort to craft a clear and compelling story for investors is leading these blockchain entities to operate more like "a corporate rather than a decentralized blockchain," in Jeff's view. This shift in communication strategy reflects a growing need to justify valuations and outline future growth in terms familiar and persuasive to traditional investors.
• Jeff, observing this evolution, states: "They're saying well actually you know we need to tell you what we're doing now. It's kind of like a corporate um rather than a decentralized blockchain."
• Actionable Insight: Researchers and investors should closely examine how L1 foundations and core development teams articulate their value capture strategies and ecosystem growth plans, particularly when engaging with TradFi capital. This "corporatization" of narrative may signal evolving governance structures and economic models within these blockchain ecosystems.

Reflective and Strategic Conclusion

This discussion underscores the shifting valuation paradigms for Layer 1s, advocating for app-driven "GDP" over volatile fee metrics. Investors and researchers must track how L1s aim to retain value as applications and Layer 2s mature, potentially reconfiguring crypto's economic landscape and demanding new strategic considerations.